Nine Questions on the Capital Market — An Exclusive Interview with CSRC Chairman Guo Shuqing
By Gong Wen and Xu Zhifeng
Published in the People’s Daily, Page 10, 1 Mar 2012
Direct Financing Still Lags Far Behind
Q: You came from a background of indirect financing and now work on direct financing. What has struck you the most in the past three months? What a role should the capital market play in facilitating real economic development as well as China’s reform and opening up? As the chairman of CSRC, what are your priorities?
A: Since I joined CSRC, I have realized more than ever how interdependent the capital market and the real economy are. On the one hand, the real economy serves as a bedrock. “Only when the real economy industries are prosperous, can the financial industry prosper. Only when the real economy industries are stable, can the financial industry stabilize.” On the other hand, the capital market, as the major platform for optimizing resource allocation, plays an irreplaceable role in funneling household savings into effective investments and accelerating industrial restructuring and upgrading.
After more than 20 years of trials and tribulations, we have established the world’s 3rd largest stock market by capitalization, 5th largest bond market by outstanding balance and one of the largest futures markets by trading volume. China’s capital market has shown an increasing capacity of serving the real economy, accelerating growth model restructuring and facilitating efforts to build an innovative nation.
However, we have to recognize the fact that direct financing in China is still far from satisfying the needs of real economic development. Indirect financing still occupies too high a proportion and accumulates too much risk. Many businesses, innovative and start-up businesses in particular, find it unlikely to get capital support from banks in their early stages. Therefore, we need to increase the size and proportion of direct financing constantly and accelerate the establishment of a multi-tier capital market. To this end, we need to expedite our work on the Growth Enterprise Board (GEB), the OTC market and bond placements.
As for our priorities in the current stage, we have named three: to strengthen the fair competition order of the market and protect investors’ legitimate rights and interests; to enhance the capacity of serving the real economy and, in particular, to strengthen the weak points; and to support technological innovation and cultural advancement.
We Cannot Afford to Ignore Imbalances in the Financial System
Q: The significance of direct financing has been stressed over and over again since the first National Financial Work Conference. However, bank deposit and lending still dominate the financial markets. What are its causes and consequences?
A: Direct financing, excluding government bonds and policy financial bonds, has indeed grown slowly. In 2011, the corporate sector raised only 20% of their capital via the securities market--a proportion that was even lower than the previous year. The total outstanding balance of loans was RMB 56 trillion as of 2011 year-end; in contrast, the combined value of the stock market and outstanding corporate bonds was only RMB 26 trillion. Moreover, banks account for 92% of the aggregate assets of financial institutions, whereas insurance, securities and mutual fund companies only account for 8% in total. International experiences have shown that such a financial system that relies excessively on credit can cause systemic risks under certain circumstances.
More importantly, such a financial system will not have adequate capacity to serve the real economy. According to The Global Competitiveness Report 2011-2012 issued by the World Economic Forum, China ranks 26th on the Global Competitiveness Index, 48th for financial market development and 60th for availability of financial services. The agricultural sector, hi-tech and innovative businesses as well as the cultural and creative industry are still severely underserved by the financial sector. The mismatch between the abundant private capital with limited investment channels and the large number of SMEs with limited access to finance is still pronounced, which indicates the severity of financial depression in the economy.
The structure of direct financing per se is not reasonable either, with disproportionate development of the stock and bond markets. The outstanding balance of corporate bonds is less than 1/4 of the stock market capitalization. Moreover, the bond market is still dominated by rates products such as government bonds and financial bonds. Corporate bonds only account for 1/5 of all bonds outstanding. Even the segment of corporate bond market is not developing in a balanced manner. The exchange-traded market is dwarfed by the inter-bank market, with the latter contributing to 97% of the combined depository balance. Interconnection between the two markets still hasn't been set up.
The structure of the stock market is also worrisome in three aspects. First, primary market prices far exceed those on the secondary market. The average P/E ratio of new shares issued last year was 47, much higher than the average of 17.76 on Shanghai and Shenzhen stock exchanges throughout the year. Second, blue-chip companies have better quality, but considerably lower stock prices compared with non-blue-chips. However, the average P/E ratio in developed markets is often the same as that of blue-chips. Third, some poorly-performing stocks have ultra-high prices. The prices of some ST stocks severely deviate from their inner value due to investors' expectations for M&As and the concept of "shell company resources".
The structural imbalance of the financial system is a potential risk factor, which showcases the immaturities of China's markets. Such a structure reduces the efficiency of resource allocation and hampers the functioning of the financial system. It merits attention from all parities involved.
It is High Time to Advocate Rational Investment
Q: China’s stock investors have always had a preference for new, small and poorly-performing stocks. The regulator has been promoting the philosophy of long-term investment and value investment for many years, but with little progress. Can investor education really work?
A: As of the end of 2011, natural persons held 26.5% of free-float A-shares by capitalization; however, they contributed to more than 85% of the trading volume. About 70% of IPO shares are subscribed by retail investors, who also own 99.8% of the accounts that participate in first day trading of IPOs. Due to the influence of China's cultural conventions, investors are easily drawn to "insider news” and “hot topics” and therefore, tend to trade on rumors and chase performance. As a result, it is the small- and medium-sized investors who bear the major risks caused by high offering prices. The phenonmenon, together with investors' preference for new, small and poorly-performing stocks, has undermined the stock market's function of resource allocation and distorted the market structure at the most basic level.
We advocate rational investment by taking a strong stand against expectations of overnight fortunes and promoting long-term investment, value investment and the philosophy of "buyers aware". In most cases, stock investment should follow common sense. First, buy large-cap performance stocks. Second, diversify properly. Third, don't buy high.
We must repeatedly remind investors that the P/E ratio is the ratio of a company's share price to its per-share earnings. The reciprocal of the P/E ratio is the Return on Investment (ROI). If a stock has a P/E ratio of 20, its ROI is 5%. A P/E ratio of 25 corresponds to a 4% ROI, which may not beat inflation. If a stock's P/E ratio shoots up to 40 or even 50, its ROI drops to 2.5% or 2%. The static payback period would be 40 to 50 years, which means it would take 40 to 50 years to recover the invested capital, unless you are definitely sure it is a true high-growth company.
China’s stock market has been overvalued for a long time, with the average P/E ratio touching high double digits from time to time. But the ratio has dropped to a historic low and is now comparable to that of major international markets. Currently the stock market is suitable for long-term investment. Therefore, it is the best time now to advocate rational investment.
Links between Technological Innovations and the Capital Market Should be Smoother
Q: The A-share market does not lack high-growth businesses. However, we have noticed that many good domestic companies that grew rapidly within a few years did not end up in the A-share market. What else shall we do to enable the capital market nurture and attract businesses with good growth prospects and enhance the quality of listed companies?
A: The capital market can easily mobilize resources towards innovation and business start-ups because risks are mutualized, but benefits are shared. Therefore, the capital market is, by nature, capable of facilitating the development of hi-tech as well as cultural and creative industries. Experiences of developed countries have shown that the capital market can play a crucial role in accelerating national economic restructuring and developing strategic emerging industries.
The four major emerging industries in the world in the past 30 years, namely, computer, communications, Internet and biopharmaceuticals, were all discovered and supported by the capital market.
Compared with developed countries, China’s capital market, like China’s economy and financial industry, is not sophisticated; the composition of listed companies is not ideal. Our market has enabled many hi-tech companies to go public and offer shares, but most of the companies are rather mature. But a large number of companies that are really in their early stages, in emerging industries or in new business models, still don't have access to the capital market. We need to think how to bring technological innovations to the capital market more smoothly.
The next stage in the development of the multi-tier capital market is to design the framework for an off-exchange market, an OTC market and a PE market. We have to factor the respective features of knowledge-intensive, technologically innovative, agriculture-oriented or small/micro businesses into the institutional arrangements. By doing so, we can improve the resilience and inclusiveness of China's capital market, make it accommodate different types of innovative businesses, and better turn technological potentials into productivity gains. It is the key to avoiding China's "middle income trap" in the future.
Intensified Efforts Should Be Made to Nurture Institutional Investors
Q: The regulator raised the idea of expanding the institutional investor base more than a decade ago. Professional institutions showed good development momentum in one period, but seem to have slowed down in recent years. The sound development of the capital market requires a diversified and sophisticated investor base, although opinions differ. How do you make of it?
A: Compared with individual investors, institutions are more professional and have advantages in many aspects. They play an important role in stabilizing the market thanks to their preference for value investment and long-term investment. In developed markets, institutions usually hold 70% of the shares by capitalization. Long-term investors including pension funds and insurance companies account for half of them. The other half includes a large number of public welfare foundations and endowment funds.
When compared with their counterparts in mature markets, the institutional investors in China are much smaller in size, and they account for only a small part in the entire investor base. By the end of 2011, for instance, the negotiable A-shares held by institutional investors made up merely 15.6% of the total market capitalization, whereas that held by the natural persons and legal persons of enterprises took 26.5% and 57.9% respectively. With such markedly imbalanced investor structure, our capital market is very susceptible to high volatility.
Of course, institutional investors are not able to fully rid themselves of impulsiveness and herd behaviors, and they also vary from one another in its features. But they should be put on top of our agenda. We shall facilitate the fund companies to transform into modernized asset management institutions, and work with the social security fund, corporate annuity and insurance companies to determine the portfolios based on their needs. We will provide guidance to private equity fund to be more transparent and well-regulated. Besides, we will accelerate moves to bring into China the Qualified Foreign Institutional Investors (QFII), especially those from Hong Kong and Macau, and encourage them to use Renminbi-denominated products. Particular weight will be given to the exchange-traded fund (ETF).
Investor Returns Systems Will Be Improved
Q: We’ve noticed the series of fresh measures announced by CSRC recently. Well, some say this is a result of a “new broom”. Among all these new moves, the one on improving cash dividends by listed companies has come under the closest scrutiny. What detailed measures will be taken to encourage listed companies to pay more returns to investors?
A: I strongly disapprove of the saying of “a new broom sweeps clean”. Because all those matters are what the CSRC has been or will be committed to, and none of them allows of any delay. Due to historical reasons, the systems on stake bound and investment returns have not yet deeply rooted in our economy. A large number of listed companies do not have an intention to pay cash dividends, nor take any initiative to pay returns to their shareholders. Apparently, this hurts the market and undermines confidence of investors. But here are some things needed to be clarified. Under the Company Law, profit allocation is at the discretion of the listed company itself. Only the board and shareholder meeting of that company have the power to decide whether pay dividends to investors or not. The regulators shall encourage and guide the company, by respecting its independent operations, to establish an ongoing, clear and transparent decision-making process and dividends policies. The Company Law provides that regulators should require the company planning to launch IPO to disclose in its prospectus the policies of profit allocation, and clarify the opinions of the independent directors and external supervisors; guide the listed company to specify the plans for shareholder return; cut the operational cost in relation to dividend payment; strengthen the supervision and examination of listed companies in their decision-making process, execution of and information disclosure on dividend policies. I believe all these arrangements will generate positive results.
In the case of companies having positive net profit but failing to pay dividends, regional offices of CSRC have already sounded them out, and will urge them to disclose the reasons for not paying dividends, use of the retained earnings, estimated earnings, and causes for the gap between actual earnings and estimated earnings. For those failing to pay by the prescribed ratio, or those failing to pay dividends for long, we will help them build the culture of returning shareholders, and improve their corporate governance. What’s worth mentioning is the introduction of delisting rules. Theoretically, everybody welcomes it. But, when it comes to a specific company, region or investor, obstacles of some kind will arise. So, not only do we need active and prudential regulators and exchanges, but also the understanding, support and collaboration from all concerned parties.
Reducing Overpricing is the Key to New Issue System Reform
Q: The markets have high expectations for the reform of new issue system. Some argue that it should take the registration form instead of the approval form. Do you think all conditions are already there? And what would be most acute issues to address in the reform?
A: To take the approval form or the registration form is not the key here. The key is how to define the responsibilities and obligations of government regulators, exchanges and market intermediaries, and how to ensure thorough, exact and full disclosure of relevant information by companies. In some markets adopting the registration form, review of the companies is far more stringent and detailed than that in China. Given that there are tens of thousands of joint stock companies above designated scale in our country, it would be a mounting task to fully open the tap and let them get listed on exchanges. We need to speed up the building of multi-tiered capital markets. At the same time, we will shift our review focus from profitability to protection of investors’ legitimate rights and interest.
Having gone through the previous rounds of reforms, we have seen stronger market discipline and declining P/E ratio of new issues. Nowadays, a new issue is no longer like a princess who may lack anything but wooers. Investors become more prudent when buying new issues, and other market participants know better their roles and responsibilities. That’s why we saw suspension cases like Baling Technology Co., Ltd. and Longmaster Information &Technology Co., Ltd... The reason for the usually high price of new issues is that investors are excessively enthusiastic about those new issues.Opinions are divided about new issues. Some say flames could rise high when everybody adds wood into it, while others believe you get the benefit at your own cost. Anyway, a scarcely few could profit from this. It is a fact that we all should see through at the first place.
Deepening market-oriented reform of issue system is one of the priorities announced at the National Conference on Financial Work. From now on to the near future, we will focus on tightening pricing constraints from the purchase side, enhancing pricing responsibility of underwriters, increasing the tradability of shares, strengthening supervision on pricing behaviors, improving pricing mechanism, curbing high offering price, high P/E ratio and over subscribition and malicious hype up of new issues. In the longer term, we will have to focus as well on bettering quality of information disclosure, social monitoring and the legal systems.
From a regulator’s perspective, we will be more centered on information disclosure, improving the quality of financial reports and dampening down any window dressing attempt by the companies. More market forces will be invited to assess the planned IPOs and alert the public to the potential risks specific to the company. More investors will also be invited to monitor the pricing. We have just extended the time for pre-announcing the prospectus, and introduced the industry average P/E ratio calculated by professional agencies. In the future, we will try more targeted measures.
Intense Combat on Insider Trading Will Continue
Q: Intense combats on insider trading and other unlawful acts are the highlight in the regulators’ latest efforts. However, due to the incomplete legal systems, inadequate punishment and surprisingly low cost of violations, various kinds of market abuse are still pronounced in the securities market. What will CSRC do to improve market integrity?
A: Creditability and punishment are both important. As for credibility, its foundation shall be integrity, for with integrity comes credibility. As for punishment, its ultimate purpose is to prevent repeated mistakes. Starting from the end of 2011, we have announced to the public 30 cases of legal violations.
In the future, we will intensify our efforts to fight against insider trading, market manipulation, fraud listings, false disclosures and other violations of laws and regulations. We will move faster once problems are detected, and will never be soft-hearted for those severe violations, because we intend to prevent future occurrence through such heavy investigations and handlings.
Insider trading is a common challenge facing all regulators. As one such case usually involves a lot of people and different accounts in wide geographic locations, it is therefore particularly hard to prove that suspects have known and spread the tips. It requires huge input of time and human resources. Besides, the coordination efforts will hit obstacles as well, in that the capital market is nationally unified, but the listed firms scatter all around the country. Apart from the local protectionism, absence of professionals at the enforcement departments is also a big problem.
However, we will continue with our intense fight by making full use of the existing comprehensive systems. Additionally, we can also learn from best practices in foreign countries. For instance, the settlement arrangement has played a big role in the handling of insider trading cases, under which the probed parties accept the execution measures while neither acknowledge nor deny the charges. For one thing, this could help increase the regulatory effectiveness, and for another, the victims could get the compensation relatively fast, and it could set examples for prospective rule-breakers in the future.
Waiving Implicit Government Endorsement is Key to Bond Market Reform
Q: One of the priorities this year is to advance reform in bond market. Could you please explain in detail the directions for its future development?
A: For the bond market in China, there are multiple regulators and incomplete risk control system for repayment, and the credit responsibility is also vague. The need to get approval from different authorities will lead to some sort of implicit endorsement or guarantee. If that continues down this road, significant systemic risks will emerge. Under the requirement of the State Council, PBOC, NDRC and CSRC have set up a primary coordination mechanism. We are trying to unify the requirements for market access, information disclosure, credit ratings, and investor suitability and protection. Built on that, further efforts will be made to connect markets both in and out of exchanges, so as to build a well-regulated and unified bond market in China.
More new moves are required to develop the bond market. Among others, the high-yield bond can be initiated to complement the current bond market system and better meet the diversified needs for financing and investment. We are considering launching the SME Private Placement Bond. As one class of the corporate bond, it invites market demand for, but not limited to, the high-yield bond. There is no legal obstacle to move before introducing it to the market, and it can enrich the financing instruments and channels for the SMEs and micro-enterprises. Having finished our primary surveys among local governments, potential issuers and intermediaries, we are now dedicated to developing the detailed arrangements. In addition, products like municipal government bond and agency bond are helpful to finance the building of infrastructure, improve the transparency of local governments’ debt obligations and diversify banks’ risks. We are also creating conditions for their growth. Last but not least, after a long period of preparations, the treasury bond futures are expected to be launched in the near future.